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How to move from austerity to prosperity

ON Tuesday evening, the Caribbean Policy Research Institute (CaPRI), in conjunction with the World Bank, hosted a dinner for Minister of Finance, Trade and Investment for the Seychelles, Pierre F Laporte, and Financial Secretary in the Ministry of Finance and Economic Development for Mauritius, Ali Mansoor.

World Bank Director for the Caribbean Francoise Clottes observed that their involvement (through the representatives of Mauritius and Seychelles kindly answering their call) was partly in response to former Minister of Finance Audley Shaw ‘s question “Where is the growth?”.

According to CaPRI Codirectors Dr Christopher Tufton and Dr Damien King, CAPRI was not arguing that one size fits all, but the two countries provide excellent case studies of small, highly indebted post-colonial Island economies facing similar challenges. Both economies had implemented tough reform programmes with substantial help from the World Bank, and were now seeing the benefits of the programmes. In the words of Dr King, they showed that our “fate was in our own hands”.

Seychelles had been in the more difficult situation in 2008, with foreign reserves near zero, unable to pay for an oil tanker in Port to offload its vital cargo, and a debt to GDP ratio of 135 per cent. As a consequence, as part of their IMF agreement, they had to take severe measures, restructuring their debt . Their restructuring included a 45 per cent reduction in principal for government to government (Paris Club) debt, private bondholders and even multilaterals. Debt to GDP had now fallen to 75 per cent.

Minister LaPorte observed that whether they had the IMF or not, they had no choice but to reform, and that the longer they waited (they were 18 years too late), the more they hurt. After the collapse of the Soviet Union (from which they had received subsidies), Seychelles discovered the international bond market, starting with only a US$20-million loan through Citibank, and in the decade to 2008, debt had risen from US$150 million to US$850 million.

Mauritius Financial Secretary Ali Mansoor noted that in 2006, Mauritius was going the way of Seychelles, suffering from economic shocks from the impact of changes to the multi-fibre agreement on its large textile industry, resulting in a 30 per cent loss of textile jobs, and more than 20 per cent loss of output in just one year, coupled with rising commodity prices for petroleum and food. The new Minister of Finance decided to undertake a comprehensive reform programme, reforms that should have been done ten years ago. The Financial Secretary advised his new Minister of Finance to do all the tough reforms in his first year. If they had been done earlier, they could have been sequenced in a more leisurely fashion.

According to Mansoor, there is no trade-off between stimulus and austerity when you have run out of money, and that rather than stimulus that you can't afford, the best alternative is to unlock growth through reform.

Noting that the correct answer to the new Minister of Finance’s first question, “where are the low hanging fruit?” was that they “had been picked long ago”, he observed that radical reform required the willingness to confront lobbies (even direct government supporters), which included the trade unions and sections of the business community. In fact, the only lobby in Mauritius they didn't go after was the religious lobby, as their new Minister of Finance thought they needed some people to pray for them.

Through the help of the World Bank, they brought in former Irish Prime Minister Garret Fitzgerald and former New Zealand Prime Minister Helen Clark to stiffen the nerve of the Cabinet, and communicate to the press and the wider population the benefits of aggressive reform in an economic crisis. In fact, he observed that, in a globalised world the costs of not reforming and the benefits of reform, are seen much faster than before, even as early as 12 to 18 months.

In Mauritius’s case, “we did not raise taxes and did not cut services”. In fact, Mauritius cut tax rates and got more revenue. This was because, unlike in the US, where for the most part people pay their taxes, in Mauritius only 30 per cent of doctors and lawyers were reporting income above the tax threshold.

Mauritius implemented a flat tax of 15 per cent on both personal income and corporate earnings, near zero import duties and a uniform rate of GCT of 15 per cent. They would have gone for an even lower 10 per cent corporate tax rate (like the Irish), to attract more foreign investment, if their finances had allowed it. By having no differential between corporate and personal income tax, they avoided people setting up companies to reduce their taxes. Taxes became both reasonable, and above all predictable.

On paper this was regressive, but in reality was mildly progressive, as a rising threshold took many of the poorest out of the tax net (and lower import duties reduced the cost of food and other items), and sharply increased the average effective tax rate on the income of the richer segment of society, from around three to five per cent to a much higher 11 per cent, partly through a withholding tax on interest and professional fees, and increased property taxation. The key was to keep tax reform very simple, combined with aggressive enforcement to identify conspicuous consumption to see who was not paying their fair share of tax. For example, they sent tax inspectors to the law courts to see who was practising law without paying taxes.

Spending was also restructured, with all new spending programmes justified by their respective ministries on a three-year rolling budget. Although zero-based budgeting would have been the ideal, this budget system worked in controlling spending because most ministries found it difficult to justify their increased spending.

The key investment objective was to “crowd in” private investments to create jobs, so that in a public private partnership, all the commercial risk was passed to the private sector, and the government only bears financing risk, with the operator servicing the debt. Gross public debt therefore goes up, but not net debt. Finally, in both Mauritius and Seychelles, there was an enormous effort to improve their rankings in the World Bank's Doing Business Report, with Mauritius, now at 23 out of more than 180 countries, being narrowly beaten by Georgia as the most improved place to do business.